Key Takeaways
- Often referred to as bps or bips, basis points are regularly used to express interest rate changes of less than 1%.
- Annuity providers use basis points to disclose annuity fees, interest rate spreads and crediting rates.
- Investors use basis points to compare fee structures and evaluate the investment performance of stocks, bonds, mutual funds, mortgage loans and other financial instruments.
Why Are Basis Points Used?
Basis points, also known as bps or bips, are a straightforward way to express granular changes in percentage-based measures. They give market participants a clear means to gauge very small or very large changes in interest rates. The concept can be somewhat confusing to people who are used to working with data expressed in percentages, but it can be easily grasped with some exposure.
The U.S. Federal Reserve, for example, communicates its federal funds rate changes in terms of basis points. Since 2021, most of its rate hikes have entailed moves of 25 basis points, or 0.25%.
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Price Value of a Basis Point (PVPB)
One basis point equals one-hundredth of 1%, which is equivalent to 0.01% or 0.0001. Therefore, 100 basis points are equal to 1%, which is equivalent to 0.01.
You can use a calculator or simple arithmetic to convert basis points to a percentage and, likewise, a percentage to basis points.
How Do Annuity Providers Use Basis Points?
Annuity providers use basis points to disclose annuity fees, such as agent commissions, administrative fees, surrender charges and mortality expenses. Basis points are also used to disclose interest rate spreads and crediting rate changes. In many instances, they are also used to express historical rate differences between products and crediting methods.
Understanding basis points can help consumers quantify the financial impact of these variables. Ultimately, this aids decision-making and optimizes the quality of retirement plans.
How Do Investors Use Basis Points?
Basis points impact a myriad of financial instruments in addition to annuities, including treasury bonds, corporate bonds, common stocks, mortgage loans and fund-style vehicles, such as mutual funds and exchange-traded funds (ETFs).
Investors use basis points to compare the fee structures of these vehicles and evaluate investment performance. For some high-net-worth individuals and institutional investors, a few basis points of performance can equate to massive amounts of money.
Other Frequently Asked Questions About Basis Points
The price value of a basis point is the measure of change in the price of a bond resulting from a one-basis-point change. It is used to assess price volatility and interest rate risk.
Dollar duration is the measure of change in the price of a bond in dollar terms, resulting from a change in the market interest rate of 100 basis points. It provides an indication of the interest-rate sensitivity of a bond.
Basis points allow traders and analysts to describe and interpret movements in interest rates and other investment variables in a granular fashion.
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